Different types of Letter of Credit

By Sakshi Srivastava - 29 Jan 2022 Last Updated: 17 May 2022
Different types of Letter of Credit

International traders, in general, rely on financial intermediaries such as banks to ensure payment and delivery of goods. Furthermore, monetary advances or trade credits are more likely to occur if both parties have established a trusting connection. As a result, various types of Letters of Credit are utilized to sustain these connections.

To clarify, Letters of Credit (LCs) are financial instruments supplied by a third party – typically a financial institution such as a bank – that guarantee payment to the seller in the event that the buyer is unable to pay the seller otherwise. Furthermore, the Letter is reliant on the proper documents being provided, but they are regularly used.

Furthermore, Letters of Credit come in a variety of forms, each of which is tailored to a certain situation. In trade transactions, different types of letter of credit (LC) are used. In this post, we'll categories them according to their intended use. Commercial, Export/Import, Transferable and Non-Transferable, Revocable and Irrevocable, Stand-by, Confirmed, and Unconfirmed, Revolving, Back to Back, Red Clause, Green Clause, Sight, Deferred Payment, and Direct Pay LC are the different types.

In trade operations, a letter of credit is an important financial tool. The LC is used to ease payments and transactions in both the domestic and foreign markets. A bank or financial institution operates as a middleman between the buyer and the seller, guaranteeing the payment of monies after certain responsibilities are met.

Letter of Credit

An LC is a financial instrument issued by a third party (with no direct interest in the transaction), usually a bank or financial institution, that guarantees payment of funds for goods and services to the seller once the seller produces the requisite paperwork. The beneficiary/seller, who is the LC's recipient, the buyer/applicant, who purchases the products or services, and the issuing bank, who issues the LC at the buyer's request, is the three main components of a letter of credit. Another bank may be involved as an advising bank that advises the beneficiary at times.

Types of Letters of Credit

In trade transactions, there are numerous forms of letters of credit. The function of some of these is used to classify them. The following are the several sorts of credit letters:

LC for business

A documentary credit is another name for a standard LC.

LC for Export/Import

Depending on who uses it, the same LC becomes an export or import LC. It will be referred to as an exporter letter of credit by the exporter, and an importer letter of credit by the importer.

LC that can be transferred

A letter of credit that permits a beneficiary to transfer all or part of a payment to another beneficiary or another supplier in the chain. This is most common when the beneficiary is merely a middleman for the actual supplier. This type of LC allows the beneficiary to furnish its own documentation while still transferring the funds.

LC that is Untransferable

A letter of credit that prevents money from being transferred to third parties. The money goes to the beneficiary alone, and the letter of credit cannot be used to pay anybody else.

LC that is revocable

An LC can be changed at any moment by the issuing bank or the buyer without notifying the seller or beneficiary. Because the beneficiary is not protected, these types of letters are not commonly used.

Irrevocable Letter of Credit

An LC that prohibits the issuing bank from making any changes without the consent of all parties.

LC on reserve

A letter of credit guarantees payment in the event that the buyer fails to pay. If the seller establishes that the promised payment was not made after completing all of the terms under SBLC. In this case, the bank will compensate the seller. In a nutshell, it ensures payment rather than facilitating a transaction. It's comparable to a bank guarantee.

Confirmed LC

A confirmed LC is one in which the seller or exporter obtains payment assurance from a confirming bank (also called the second bank). This is primarily to avoid the danger of the first bank failing to pay.

LC that hasn't been verified

A letter of credit that is just guaranteed by the issuing bank and does not require a second bank's guarantee. The letters of credit are almost often unsubstantiated letters of credit.

LC revolving

A revolving LC is one that is issued to cover several transactions rather than issuing individual LCs for each transaction. They can be further divided into two types: time-based (which can be cumulative or non-cumulative) and value-based (which can be cumulative or non-cumulative).

Back-to-Back LC

Back-to-back LC is a type of LC that frequently involves the use of an intermediary in the transaction. The first letter of credit is granted by the buyer's bank to the intermediary, and the second is issued by the intermediary's bank to the seller.

Red Clause LC

A letter of credit that pays the beneficiary partially before the goods or services is delivered. The advance is paid in exchange for the seller's written confirmation and the receipt.

Green Clause LC

A letter of credit that pays the seller in advance is not only a written undertaking and a receipt, but also proof of warehousing the products.

Observe LC

A letter of credit that requires payment upon receipt of the necessary documentation. The bank examines the documents and pays the beneficiary if they fulfill the letter's requirements.

Deferred LC for payment

A letter of credit that guarantees payment after a set length of time. The bank may verify the documentation before paying the recipient, but only after the agreed-upon time has passed. Usance LC is another name for it.

LC for Direct Payment

A letter of credit in which the issuing bank pays the recipient immediately and then demands repayment from the buyer. The recipient is not permitted to communicate with the buyer.

Conclusion

As previously said, depending on the purpose of the letter of credit, it can be of numerous sorts. Both the buyer and the seller have an interest in thoroughly understanding all of the different varieties and then selecting the one that best meets their needs. If you are having more query on Letter of Credit you can connect with experts of Dhanguard and get some more details on it.

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Letter of Credit is a financial document that is used in international trade. It is a payment guarantee offered by the bank to the supplier of the goods.

By Sakshi Srivastava

29-Jan, 2022

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